Apex court ruling gives BPOs more leeway

The Supreme Court ruling today on captive business process outsourcing units has settled an important question of law, while leaving some others open.

Stating this, revenue department officials said the ruling would encourage parent companies to send executives from abroad for short tenures to assist their Indian outfits.

The apex court ruling held that the units are not liable to be taxed in the country if they are billing the subsidiaries on an "arm's length" basis or without giving any preference.

"This ruling, while settling the law on the issue, is likely to encourage agreements between principal and associated enterprises which promote controls through this stewardship route," a revenue department source said.

The judgement will now be studied in detail by the department with regard to its implementation. Officials added that the field had been left wide open for further tax litigation on the issue of transfer pricing.

On their part, leading tax experts maintain that the ruling does not have a negative impact on foreign companies that have captive business process outsourcing units (BPOs) in India.

"The revenue department had taken an aggressive stance, saying that business process outsourcing units will create a permanent establishment (PE) in the country. The Supreme Court has now affirmed the Authority of Advance Rulings that this is not the case," said Rahul Kumar Mitra, executive director, PricewaterhouseCoopers.

On the issue of whether Morgan Stanley Advantage Services was indeed a permanent establishment of Morgan Stanley Company of USA, the Court has ruled that it is a service permanent establishment, only on account of the services to be performed by deputationists deployed by the foreign parent.

The issue was a major one for foreign companies that have set up captive BPOs in India for information technology outsourcing and other back office functions.

"This is a misnomer, since if at all, technicians (deputationists) would be in India beyond the threshold period for creating a service permanent establishment, that permanent establishment would be created by virtue of presence of technicians. The Indian BPO unit could never create a service permanent establishment of the foreign company," Mitra said.

The court has also observed that "economic nexus is an important aspect of the principle of attribution of profits" when read in conjunction with its observation that "the situation would be different if the transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise".

This implies that even if the transaction between principal and associate enterprises has been taxed at the appropriate arm's length price, tax authorities could still attribute further profits to the PE, which are not covered in the transfer pricing method.

"This has left the field wide open to further litigation," the revenue department official added.